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Clash of the regulatory systems

Editor's letter

In the nineteenth century, Europe's great powers and the US vied for influence in Latin America, while Tsarist Russia and Britain played imperialist chess across central Asia. In the twentieth century, the US and the Soviet bloc squared off throughout the developing world in a mighty ideological confrontation, the Cold War.

In the twenty-first century, a more subtle contest between the US and the European Union can be witnessed as industry and regulators seek to persuade emerging market countries to adopt a particular solvency framework. Members of the US National Association of Insurance Commissioners (NAIC) sign up countries like Thailand and Chile in memorandums of understanding. Members of the EU's Committee of European Insurance & Occupational Pensions Supervisors (CEIOPS) advise countries like Singapore on the market-consistent approach of Solvency II.

This is not just about ideological kudos. Insurance multinationals based in the EU or the US are keen to see their domestic solvency framework mirrored in as many jurisdictions as possible in order to reap the benefits of a centralised economic capital model, and its supporting infrastructure. Better still is the holy grail of mutual regulatory equivalence where group support in one regime is recognised as solvency capital in another. Some multinationals see this as an important mechanism for growth.

For the emerging market regulator, the prospect of multinational investment can be attractive, particularly for countries that seek to anticipate demographic shifts by building up a private sector life savings industry. However, if such a regulator decides to adopt the EU approach, it risks raising barriers to US investment, and vice versa. Some multinationals may seek to pre-empt this by launching businesses in emerging markets, such as variable annuities, that pull the regulator into a favoured supervisory orbit.

Moreover, as countries like China become financial services centres in their own right, there is the possibility of leveraging regulatory alignment to enable domestically-based multinationals to expand into western markets. We have already seen Shenzhen giant Ping An take a stake in EU-based Fortis, and it will be interesting to see who takes a stake in capital-strapped AIG.

In the middle of all this tussling for influence, one has to applaud the high-minded initiatives to discuss global insurance solvency standards, although as bankers never tire of pointing out, there is no such thing as a global insurance system. But banking too has its regulatory battlegrounds, and here insurance has lessons to learn.

A lesson from the US and elsewhere is that regulation can be a business too, particularly if the level of funding for a supervisor is linked to the number of companies it supervises. Some believe that the US mortgage lending bubble was fostered by state-level regulation of this type.

Then there is the dangerous habit of financial institutions finding off-balance sheet ways to warehouse risk. This warehouse can be an unregulated branch in a local subsidiary, or an entity in a different financial sector. Regulators will always try to close such loopholes off, but financial innovators constantly find new ones. From emerging market countries to competitive business segments in a particular market, regulators and the regulated seem destined to jockey for influence for years to come.